On Nov. 20, 2015, the Internal Revenue Service issued Notice 2015-81(the Notice) providing interim guidance clarifying the criteria for establishing qualified Achieving Better Life Experience (ABLE) accounts. Pending the issuance of final regulations, taxpayers and states may rely on the interim guidance with respect to implementing qualified ABLE account programs.
Section 529A of the Internal Revenue Code, which became law in December 2014, allows a state to establish and maintain a tax-advantaged savings program called an ABLE account. ABLE accounts are modeled after IRC Section 529 plans and provide a mechanism to fund an account in the name of certain individuals with disabilities and allow the funds in that account to accumulate income tax-free. Moreover, if certain conditions are met, the assets contained in the ABLE account won’t disqualify the beneficiary from Medicaid and Supplemental Security Income (SSI). To be eligible for an ABLE account, the onset of the individual’s disability must have occurred prior to age 26.
Distributions made from ABLE accounts for qualified disability expenses of the designated beneficiary aren’t included in his gross income for federal income tax purposes. However, if distributions from the account are for items other than qualified disability expenses, then the earnings portion of the distribution is includible in his gross income.
Proposed regulations issued in June 2015 by the Treasury Department and the IRS outlined the requirements for establishing ABLE programs, including the implementation of safeguards to: (1) categorize distributions as qualified or not; (2) collect taxpayer identification numbers (TIN) from contributors at the time of the contribution; and (3) determine whether the disability occurred prior to age 26. Commenters to the proposed regulations noted that such safeguards would impose substantial administrative and cost burdens on the states administering the ABLE programs and could perhaps become an impediment to states’ adopting ABLE account programs.
ABLE Distributions for Qualified Disability Expenses
So long as the funds in the ABLE account are used for permitted government-approved disability-related expenditures, the account will continue to accrue value income tax free. Examples of qualified disability expenses include: housing, transportation, employment training, education, health and wellness. The proposed regulations provide that a qualified ABLE program must establish safeguards to allow the ABLE program to distinguish between distributions used to pay for qualified disability expenses and other distributions, and to identify the amounts distributed for housing expenses.
The Notice provides that ABLE programs don’t need to include safeguards to determine whether distributions are for qualified disability expenses nor are they required to specifically identify those used for housing expenses. Commenters noted that such a requirement is unduly burdensome and, in some cases, the use of the distribution may not be known at the time it’s made. However, the designated beneficiary will still need to categorize distributions to properly determine whether the distribution is taxable or not.
Reporting Requirements for Contributors
The proposed regulations require that a qualified ABLE program must provide that no contribution to an ABLE account will be accepted to the extent that such contribution exceeds certain stated limits. Namely, (1) annual contributions can’t exceed the federal annual gift tax exclusion amount (currently $14,000), and (2) the aggregate amount of all contributions to an ABLE account mustn’t exceed the state-imposed limits for Section 529 accounts. Once the limit is reached, no additional contributions can be made, but the ABLE account can continue to accumulate earnings.
Excess contributions to an ABLE account are required to be returned to the person who made the contribution. The income earned on such excess contributions to ABLE accounts is taxable to the contributor. The proposed regulations require qualified ABLE programs to request the TINs for each contributor to the ABLE account at the time a contribution is made if the ABLE program doesn’t already have a record of that person’s TIN. Commenters expressed concern about the substantial burden imposed of having to request the TIN of every contributor at the time of contribution as contributions likely come from multiple sources, and some contributors may be reluctant to make a contribution if their TIN is required.
The Notice eliminates the requirement that TINs must be requested at the time of contribution if the qualified ABLE program has a system in place to identify and reject excess annual and aggregate contributions before they’re deposited into an ABLE account. In the event that an excess contribution is deposited into an ABLE account, the ABLE program is still obligated to request the contributor’s TIN.
Documentation Establishing Eligibility of Designated Beneficiary
An ABLE account can only be established for someone who has a disability. If the individual is receiving SSI or Social Security Disability, then he’ll already have an award letter from the Social Security Administration indicating that he has a disability. Anyone else who wishes to establish an ABLE account will have to provide documentation that the onset of their disability occurred before age 26. The proposed regulations require a qualified ABLE program to receive, retain and evaluate this documentation.
Commentators noted that states and potential qualified ABLE program administrators may not have the expertise in receiving and safeguarding medical information contained in a signed medical diagnosis document, and such qualified ABLE programs would incur unmanageable costs and burdens in trying to comply with applicable laws in implementing systems to receive and store paper documentation.
The Notice provides that beneficiaries may open an ABLE account by certifying, under penalties of perjury, that they meet the qualification standards, including their receipt of a signed physician’s diagnosis, if necessary. The beneficiary is required to retain that diagnosis and provide it to the ABLE program or IRS upon request.
More Useful Tool
The Notice is a big step towards ABLE accounts becoming a useful tool for special needs planning practitioners and the families they represent. Removing many of the cumbersome burdens imposed by the proposed regulations will make these accounts much more attractive. Until final regulations are issued, taxpayers and ABLE program administrators may rely on the Notice when establishing and administering ABLE accounts.